EM Intelligence Exclusive: Why Emerging Markets Now?

Given the relative importance of emerging markets which account for over 30% of total absolute global equity market capitalization, it is necessary for investors to increase their asset allocation to emerging markets in order to diversify their portfolios and benefit from their attractive valuations and potentially greater returns.

In this exclusive www.emintelligence.com interview with David Kunselman, Senior Portfolio Manager with Excel Investment Counsel Inc. in Mississauga, Ontario, David explains to Dwarka Lakhan why investors are in a strong position to benefit from the superior growth forecasted for emerging markets.

Dwarka Lakhan: In its October 2013, World Economic Outlook, the International Monetary Fund projects emerging market economic growth at 5.1%, compared to 2.0% for developed economies. In your opinion, what are the key reasons why emerging markets are expected to grow more than twice as fast as developed markets?

Kunselman: Although global growth is stabilizing and the world is back on track following the 2008-09 financial crisis, the underlying fundamentals of emerging markets are much stronger than those in developed countries. Here are some of the key facts investors need to be aware of:

At a big picture level, emerging markets have learned from their past mistakes and put measures in place to strengthen their economies, enabling them to withstand crises that previously disrupted their economies. As a result:

• The average debt to GDP ratio of emerging markets is roughly 33% which is one-third that of developed markets that is on average over 100%.
• Emerging markets currently control over 80% of the world’s foreign exchange reserves, which is a dramatic reversal of their position just a decade ago.
• Average household debt in emerging markets is less than 20%, which is one-sixth of household debt in the US and Canada which is well over 120%.
• Emerging markets have a much younger and more productive population compared to developing countries which are experiencing the negative effects of an aging population.
• Emerging markets have more flexibility to adjust interest rates downwards to deal with any global pressures whereas developed countries can only raise interest rates.
• Strong economic growth in emerging markets has been accompanied by increasing urbanization and rising per capita incomes which are contributing to greater consumption of goods and services.

Dwarka Lakhan: But some developed markets like the US have been performing well recently. Why invest in emerging markets?

Kunselman: Yes, it is true that markets like the US and Japan have produced strong performances recently. However, their valuations are now above their historical averages after massive stimulus spending by their governments. This means they are trading at a premium and do not have scope to rise much further through multiple expansion.

On the other hand, emerging markets are trading at a discount and can potentially climb higher, on the back of potential multiple expansion and earnings growth. For example, India is trading at a 24% discount to its historical book value; China at 22%, Russia at 38% and Brazil at 36%. Comparatively, the US market is trading at a 4% premium.

Dwarka Lakhan: What’s the best way to take advantage of opportunities in emerging markets?

Kunselman: The first thing you have to look at is how much exposure you currently have to emerging markets. Most people have a much lower exposure than they should. For instance, emerging markets make up 11% of total global float equity market capitalization. What this means is that at least 11% of your portfolio today should be allocated to emerging markets if you were only neutral or market weight. If you are bullish you would want more than that considering the valuation gap today is much wider comparing emerging markets to the developed world.

The second thing you have to do is find a mutual fund company that has expertise in emerging markets. For example, Excel Funds Management Inc. is the only Canadian mutual fund company that is solely focused on investing in emerging markets. It uses on-the-ground sub-advisors who live in the countries in which they invest and have firsthand knowledge and experience with these companies. This allows Excel Funds to better understand these companies through more face to face meetings to help drive consistent performance.

Dwarka Lakhan

Dwarka Lakhan is a pioneer in emerging markets journalism in Canada. His first emerging markets article, “Africa Joins Ranks of the Emerging,” appeared in Investment Executive, Canada’s leading newspaper for financial advisors, in September 1994. Since then he has written hundreds of articles on the full spectrum of emerging markets and has conducted more than two thousand interviews with emerging and frontier markets investment professionals.

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